PCCW spinoff can’t unwind tycoon discount

Richard Li’s clever spinoff of Hong Kong Telecom was supposed to do two things: raise a bit of cash, and unwind the conglomerate discount that plagues the tycoon’s holding company. It only half worked. The newly created HKT Trust has commanded a respectable price, but parent PCCW Ltd, which will keep a majority stake in the newly listed business, looks no more loved than before.

HKT’s IPO squeaked through at the bottom of the range after retail investors and hedge funds gave it a wide berth. But getting it away at all in such a fearful market is an achievement, especially since HKT’s “business trust” structure is the first of its kind in Hong Kong. At a market value of $3.8 billion, plus some $2.8 billion of net debt, HKT is worth 6.7 times next year’s forecast EBITDA – a 20 percent mark-up on the Asian telecom sector.

The reason for the premium is that HKT promises to throw off cash. As a trust, it can pay dividends from cash flow rather than accounting earnings, digging into its considerable reserves. Next year’s dividend of $330 million is almost triple its expected earnings for 2011. That’s sustainable provided HKT doesn’t have to invest in its business any time soon. Investors seem to believe that’s the case for now.

Some of the uplift may also be relief that HKT will be spared the mission creep characteristic of Asia’s tycoon-run conglomerates. The trust can only invest in the telecom industry, which along with a high dividend policy should prevent funds being sidelined into wasteful side-projects. Li’s own investment record is checkered – after all, he originally bought HKT in 2000 for $38 billion.

For Li himself, the spinoff has had an unintended consequence: exposing the discount investors place on his own holding company, which also includes a media business, a stake in a listed property group, and now some cash. Based on the sum of its parts following the spinoff, PCCW should be worth $4.3 billion, according to a Breakingviews calculation. The market valued it at 38 percent less on Nov. 23. Perhaps it’s that “tycoon discount” PCCW should really be trying to unwind.